Morningstar Tool Weighs Investment and Billed Plan Expenses

Paul Ellenbogen, head of global regulatory solutions at Morningstar, says the latest cost benchmarking solution from his firm will supply “valuable baseline information when comparing a qualified plan with a possible individual retirement account (IRA) rollover.”

The firm argues this type of analysis is critical because 404(a)5 disclosures “remain tightly guarded by plan recordkeepers and are difficult to access for plan participants and their would-be financial advisers.”

“The need to deliver best-interest advice is top-of-mind for advisers and financial institutions, specifically when helping investors determine whether to remain in a qualified plan or perform a rollover distribution into an IRA,” Ellenbogen explains. “Guidance from the Department of Labor states that in the absence of actual plan data that was reasonably attempted to be obtained, the financial institution and adviser can rely on alternative data sources, such as the most recent Form 5500 or reliable benchmarks on typical fees and expenses for the type and size of plan at issue. FINRA and the SEC have also issued guidance when assisting with rollover distributions to an IRA.”

To assist with the process, Morningstar initially built a solution that “surfaces available Form 5500 data.” But the firm is now extending that solution by creating “Qualified Retirement Plan Benchmarks,” which have been designed to help “determine baseline cost estimates, with approximate total fees based on plan asset size.”

As laid out by an accompanying Morningstar analysis, the total costs paid by participants in a DC plan can be broken down into two primary components—investment expenses and additional expenses.

“Investment expenses are the costs associated with investments available to participants in the plan,” Morningstar clarifies. “Many investments also contain some amount of monies that are used to cover plan expenses and are commonly called ‘revenue sharing.’ If the revenue sharing dollars available are not enough to cover the recordkeeping fees, administrative fees, trustee fees, etc., these additional expenses need to be paid by either the plan sponsor or billed to the individual participants.”

The research team finds that, for most plans, the investment management expenses are “significantly greater than additional billed expenses,” and are generally between 85% and 90% of the total cost of the plan.

“There has been an increasing movement among plan sponsors in recent years away from using investments that provide revenue share (e.g., to R6 share classes) and therefore we expect the relative portion of expenses billed to participants to increase,” the firm points out. “It is worth noting that just because the costs billed to participants increase does not mean the total plan costs increase. In theory, higher billed costs should be offset by lower revenue share expenses therefore lower investment management fees. In practice, cost structures vary significantly across plans and providers.”

The analysis shows total plan costs vary materially by plan, but tend to decrease as plan size increases.

“There are some very inexpensive small plans, however,” Morninstar says. “For example, there are some plans with assets of approximately $1 million that have total expenses of approximately 0.25% of plan assets (which would be $2,500 a year). The low overall cost can be attributed largely to the plan sponsor selecting low-cost investments (e.g., index funds) and likely paying directly for all administrative, recordkeeping, and trustee expenses. In contrast, there are some plans with $1 billion in assets with fees approaching 100 basis points. These plans likely rely on significantly higher cost investment options (e.g., actively managed investments), or more expensive share classes.”